This 'Tech' ETF Isn't What You Think It Is

If I were to ask a sample of investors what sector they most associate with the Nasdaq, I assume most would say "Information Technology." And if I were to ask a sample of investors to name the exchange-traded fund they would most likely purchase when seeking diversified exposure to technology stocks, I assume most investors would say "QQQ."

While the well-known Invesco PowerShares ETF, QQQ, may be the security investors turn to when seeking diversified exposure to technology stocks, it might not be providing the types of exposure and diversification that many assume it is. Let me explain:

First, QQQ is an ETF designed to track the returns of the Nasdaq 100, not all stocks listed on the Nasdaq. According to the Invesco PowerShares website, the Nasdaq 100 includes "100 of the largest domestic and international nonfinancial companies listed on the Nasdaq Stock Market based on market capitalization." At this time, there are 2,727 stocks listed on the Nasdaq, which means QQQ's 100 stocks represent just 3.67% of the total universe of Nasdaq stocks. If you would like to examine a list of all 2,727 stocks on the Nasdaq, you can download that list along with lists of all NYSE and AMEX stocks at Nasdaq.com.

Second, of the 100 stocks underlying QQQ, just 49 are members of the information technology sector. There are a total of 493 technology stocks listed on the Nasdaq. While QQQ does provide exposure to the largest stocks by market capitalization in the technology sector, it only provides exposure to 9.94% of all technology stocks listed on the Nasdaq. Other sectors in this "tech" ETF include Consumer Discretionary, Consumer Staples, Health Care, Industrials, Materials, and Telecommunication Services. In terms of how the assets are diversified among the various sectors, information technology comprises approximately two-thirds of the total assets. This is definitely something to keep in mind if you are looking for exposure only to the information technology sector.

For a few examples of companies from sectors other than technology whose stocks are a part of QQQ's holdings, see the table below:

Digging a bit deeper, you will discover that although the fund holds 100 stocks, the diversification within its portfolio leaves something to be desired. The top three holdings, Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and Google (NASDAQ:GOOG), together make up roughly one-third of the fund, a whopping 33.90%. In fact, Apple alone has a weighting of nearly 20%. If you are one of the investors who thinks it doesn't make a lot of sense to use the Dow Jones Industrial Average (NYSEARCA:DIA) as a proxy for the broader stock market, given it is made up of only 30 companies, you may end up feeling similarly with respect to QQQ being representative of any type of gauge for the broader stock market. The top thirty holdings by weighting in QQQ make up a gigantic 79.24% of the fund. The remaining 70% of the holdings make up only slightly more than 20% of the weighting.

Even though QQQ holds 100 stocks, from a weightings perspective, it is important to keep in mind that the exposure to those 100 stocks is anything but diversified. Therefore, if you are buying QQQ as a proxy for the Nasdaq or as a diversified proxy for the tech sector, you may want to look elsewhere. But just because QQQ may not be exactly what many investors imagined it to be doesn't mean the ETF can't serve a useful purpose.

If you are an investor who likes to supplement your income by selling covered calls, you may find it difficult to accumulate enough shares to do so with Apple or Google. With Apple trading at roughly $653 and Google at $768, it would cost $65,300 and $76,800 respectively just to accumulate enough shares to sell one covered call option (1 option contract = 100 shares). Those amounts may be more than you are comfortable allocating, or are able to allocate, to any one stock. Using QQQ, however, you can find a way around this problem.

Based on the current weightings within QQQ, for every $50,000 you allocate to that ETF, you would accumulate $9,829.63 of exposure to Apple and $3,164.17 of exposure to Google. Moreover, a $50,000 position in QQQ will allow you to accumulate a little more than 700 shares, more than enough to sell covered calls against. Therefore, if you would like to sell covered calls against positions in Apple and Google but find it too expensive to build big enough positions in the stocks, you could consider building those positions using QQQ and selling the covered calls against the ETF. Apple and Google together make up roughly 26% of the weighting in QQQ and will have an outsized influence on the fund's performance. While gaining exposure to those two companies through an ETF is not the purest way to do so, if it allows you to collect income on a regular basis through call premiums, it may be worth your while.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.